The President’s bigger budget

The President’s bigger budget

The President proposed his budget today. This is the budget for federal fiscal year 2011, which begins October 1 of this year.

Most people in Washington will focus on (1) the effects of the proposed budget on the deficit and (2) what the budget proposes for specific policies they happen to care about.

I will focus on the size of the proposed budget relative to the rest of the economy. The deficit is an important but incomplete measure of this. It’s important to remember that every dollar not spent by the government is a dollar that can be spent by individuals, families, and firms. We should care not just about the difference between spending and taxes, but also on how big government is relative to the private sector.

Throughout this post I will describe things as a share of the economy (% of GDP). This is a useful way to compare budgets across time but it is biased in favor of bigger government. There is nothing that says that because the economy gets bigger that the government must grow along with it. I’d like to do these presentations in real (inflation-adjusted) dollars to eliminate this bias, but it would make my analysis difficult to compare with almost everyone else’s. For now I won’t fight this and will just use % of GDP.


Deficits

Let’s begin with the deficit. As always, click on any image to see a bigger version.

The green line shows deficits as proposed by President Obama last year. The blue line shows deficits as proposed by President Obama this year. The dotted yellow line shows the deficit consistent with holding federal debt (as a share of GDP) constant. If deficits are above this dotted yellow line, then our debt burden relative to our economy’s ability to pay for it will increase. If deficits are below that line, our debt burden will decline relative to the economy. (I’m oversimplifying a bit – the dotted yellow line should actually slope gradually upward depending on what happens to debt in the intervening years.) For now this maximum is 3.0% of GDP.

We can draw five important conclusions from this graph:

  1. At 8.3% of GDP, the proposed budget deficit for 2011 is still extremely high.
  2. President Obama is proposing larger budget deficits than he did last year.
  3. For 2011, the most relevant year of this proposal, the President is proposing a budget deficit that is 2.3 percentage points higher than he did last year (8.3% vs. 6.0%).
  4. Using his own numbers, the President’s proposed budget deficits will cause debt as a share of the economy to increase.
  5. Under the President’s proposal, budget deficits begin to increase as a share of the economy beginning in 2018.

Adding further detail to (4), the President’s own figures show deficits averaging 5.1% of GDP over the next 5 years, and 4.5% of GDP over the next ten years. They further show debt held by the public increasing from 63.6% of GDP this year to 77.2% of GDP ten years from now. I think it’s a safe assumption that CBO’s rescore of the President’s budget will be even worse.

From a macroeconomic standpoint, short-run deficit reduction is contractionary. Reducing the budget deficit toward manageable levels is necessary from a federal fiscal standpoint, but it reduces short-term economic growth. This is the Administration’s core short-term economic policy challenge, the tradeoff between fiscal stimulus and deficit reduction over the next 2-3 years.


Taxes

The green line shows total revenues proposed by the President last year, and the blue line shows this year’s proposal. The dotted pink and red lines show historic averages of the past 30 and 50 years.

You can see that taxes were really low when the President took office, a consequence of the severe recession. The big jump from 2010 to 2012 is a result of several factors all pushing taxes higher:

  • as the recession ends, revenues will recover as a share of the economy;
  • President Obama proposes to allow some of the Bush tax cuts to expire on December 31 of this year;
  • He is proposing some other tax increases as well;
  • The tax code has features that build in tax increases over time. The most important is known as bracket creep.

We can draw two conclusions from this graph:

  1. Taxes are low now, but are scheduled to increase to above historic averages.
  2. The President is proposing slightly lower revenues over the next few years than he proposed last year, but essentially no difference in the long run.

Spending

I saved the most important graph for last. Every dollar spent by the government must be either taken from someone in the private sector (taxes) or borrowed from the private sector (deficits).

Again, green is last year’s proposal, blue is this year’s proposal, and dotted pink (30-years) and red (50-years) are historic averages.

We can conclude:

  1. The President is proposing significantly more spending than he proposed last year: 1.8% of GDP more in 2011, and roughly 1 percentage point more each year over time.
  2. Spending is and will continue to be way above historic averages.

At its lowest point in the next decade federal spending would still be 1.7 percentage points above the 30-year historic average. Over the next decade, President Obama proposes spending be 12% higher as a share of the economy than it has averaged over the past three decades.

Remember that fiscal policy is not just about the budget deficit, the difference between spending and taxes. It’s also about the size of government: how much is the government spending, and therefore taking from the private sector?

61 responses

  1. Keith,

    From a European perspective I would like to ask one question: Many pundits and also Obama noted, that most of the debt was piled upon on your economist's watch plus the legacy of an economy in ruins. Do you think it's fair to blame Obama now for this mess and how to judge your economic advice in retroperspective?

    • Hi Stephan,

      I'm not Keith but I'll try to explain. The Bush budget through 2007 showed a falling deficit largely representative of net interest on the privately held public debt. The primary budget was coming back into balance.

      When the recession began the Bush administration was under increasing pressure to undertake a stimulus. Congress passed and the president signed the first stimulus bill. That was for $600 billion in one time payments to individuals. It was ill designed and its effects were short lived. When the financial crisis hit the TARP program was signed into law and most of that spending was a bipartisan agreement. TARP was largely loaded into fiscal 2009 and fiscal 2010. As the recession deepened in calendar year 2008 and 2009 our automatic stabilizers, unemployment insurance, higher utilization of medicaid, foodstamps and other countercyclical mandatory programs kicked in causing the deficit to rise at an increasing rate with the worsening recession. continued in next message

  2. There is growing evidence that government size is negatively related to economic growth. So, the above-average government deficits and spending must inevitably lead to below-average economic growth for the US and probably most of the developed world. On the positive side, chances of convergence of emerging economies seem to be increasing, although the overall outlook for the global economy is somewhat mixed.

    • If that is true Somalia must be paradise on earth and Sweden like hell. Can you back up your claim: "There is growing evidence that government size is negatively related to economic growth."

  3. Keith:

    Matt P is right.

    Every deficit dollar is a dollar that the Govt has transferred to the private sector, but not taken back via taxes. Therefore it's a dollar that's available to us — not a dollar that's been taken away!

    The problem is that the Govt is busy taking away the few dollars we have when the private sector is desperately trying to rebuild its savings, savings that have been devastated through the stock market crash, the housing crash, and unemployment. And the dollars the Govt is spending are going to well connected cronies, like Goldman Sachs, and not the american family. I think the last tax rebate was for $250. Try feeding a family of four on that!

    The Obama administration budget calls for slightly higher deficits in the short term, higher taxes in the long term, and more spending to cronies. This will keep americans unemployed in the short term, push the country back into recession in the long term, and further strengthen Goldman Sachs.

    Instead, you should call for a payroll tax holiday, to be kept into effect until unemployment has improved enough that inflation begins to be a concern once more.

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  5. Keith — apparent typo in your post: I think you meant to say "above" instead of "about" where you say "If deficits are about this dotted yellow line, then our debt burden relative to our economy’s ability to pay for it will increase."

  6. Keith, re:
    There is nothing that says that because the economy gets bigger that the government must grow along with it.

    Indeed, and I would guess the opposite — that, other things equal, a growing U.S. economy would mean declining federal spending as a percent of GDP. In other words, it seems to me that — just a hypothetical — if we leave out assumptions of demographic shifts (under 65 vs. 65+), medical inflation, and any other extraneous factors, as the U.S. economy grows it would cost LESS as a percent of GDP for the federal government to provide the same level and quality of each type of "stuff" it currently provides? I say this largely because I assume that (1) only part of the growth would be due to population growth, with the other part growth in GDP per capita, and (2) a substantial amount of federal spending would be fixed or less than fully variable vis a vis population growth (e.g., Defense, some administrative and operational infrastructure, etc.). Are my assumption and reasoning correct?

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  10. It's always amusing when I hear "inherited", never state the positives inherited, and forget the spending and massive deficits came under a Democratic congress. And so it goes………..

  11. Hello Keith,

    Thank you for your contribution to understanding many of these complex issues. Your healthcare series was particularly interesting. Having said that, I must take issue with this statement: "I saved the most important graph for last. Every dollar spent by the government must be either taken from someone in the private sector (taxes) or borrowed from the private sector (deficits)."

    This is demonstrably false but is one of those things everyone assumes to be true. People confuse a money creator (US Government) with a money user (i.e. family, business, etc.). The US Gov. doesn't get its dollars from anywhere. Not from taxes, not from China. It creates them via the banking system. Taxation is actually a method to control inflation and to adjust wealth allocation to create societal goals. There is a whole line of economic thought called Modern Monetary Theory or post-Keynsian.

    Your statement assumes we are still in a gold standard environment rather than the fiat system.

    • If the Gov. creates it's money through the banking system then how is there a deficit? If taxes are not a source of revenue for the government what social goals do taxes achieve? If taxes are used to control inflation where does that money go if it isn't revenue for the Gov.?

      • Taxes are used to reallocate spendable money across sectors and to provide certain incentives via tax breaks/incentives. I know this sounds crazy but it is my understanding that if you paid your taxes in cash they would literally shred it. Think about it logically…the US Government creates dollars/credit. No one else does. What is the difference if they collect your tax dollar and re-spend it or if they collect it, shred it and create more?

    • Either the money has to come from taxes or debt instruments if we hold the money supply constant. If the money supply is expanded, it would lead directly to inflation according to the quantity theory of money. So you are implying that the Fed would further weaken the dollar to support spending increases.

      • So Josh, take a look at our money supply. Where is the inflation? We are in a deflationary environment and will be for some time. How about Japan? This country is not Zimbabwe. As Z. said below, the private sector is trying to rebuild its balance sheet. "Ttoo many dollars chasing too few goods" is the best definition of inflation — dollars have to chase goods for inflation to be an issue. If the Government prints money, and it just gets saved, then, although the money supply has been "diluted" (a la that Austrian school) from a practical perspective, it's like the money doesn't exist at all, since it just sits in checking accounts.

        Keith? What say you?

    • Your response to the comment "Every dollar spent by the government must be either taken from someone in the private sector (taxes) or borrowed from the private sector (deficits)" is demonstrably incomplete. While the government might have the ability to print money, in doing so it takes from the private sector by means of inflation (a form of taxation which results in the loss of private savings).

  12. With Obama's election another stimulus bill was signed into law, about $820 billion (latest estimate from CBO), further increasing the deficit in 2009. The bulk of this stimulus is loaded into 2010. There was also a 15% decline in all government revenues from 2008 to 2009 further increasing the deficit. If we had foregone both stimuls packages the $600 billion lump sum and the $820 billion Obama stimulus we would have had a steeper decline in aggregate demand that could have caused government revenues to fall by an amount greater than the stimului.
    (continued in next message)

  13. As I read it, the countercyclical spending is about 50% Bush and 50% Obama but actually it is neither. It is autopilot spending. The only major difference here is that Obama is benefiting from a low interest rate environment where net interest has declined by over 50% from the Bush administration. Net interest is the piano hanging by a thread as we are walking under it.

    But what of Obama's discretionary spending increases? They account at best for about 20% of the deficit but some of these increases are automatic as well. So, what's a president to do or for that matter a former community organizer to do? Surrender to the autopilot budget and go to Hawaii, often, and don't forget to take off your shirt and walk on the beach.

    Seriously, Obama is only left with his regulartory whip and his gift for oratory. Rhetoric and Regulation now that's the ticket.

    • Steven,

      Many thanks for your reply. And sorry for the late answer. It's a problem to reply timely while sitting on the other side of the pond. In regard to stimulus I agree. It's 50:50. But what about two tax cuts and the Medicare prescription drug benefit on Bush's watch? I do not want to blame him for starting two wars. But historically once you start a war either you raise taxes or your issue bonds. To lower taxes is a historical novelty ;-) You might want to have a look at the chart here:

      http://baselinescenario.com/2010/02/01/budget-sen

      Personally I think this worry about debt is totally overblown! Whole Europe has a VAT in place and despite US impression we're not impoverished savages. Thus at the end of the day the US government will introduce a modest federal VAT. Problem solved! Here in Austria we've 20% VAT. I think 5-7% VAT would do it for the US. (I'm envious ;-)

      • Stephan,

        The basic argument presented by the CBPP could be restated for any cabinet department or federal program. The assumption being that since there is a deficit we can arbitrarily add up at random a bunch of programs that total to the deficit and then calculate the carrying costs of these programs and come up with a shocking number. We could do that for the mortgage interest deduction, the childcare tax credit or the tax exemption for municipal bonds. But at the end of the day this kind of analysis is empty and doesn't tell us anything.

      • Taking on your other points. The drug benefit has come in below projections and there is some indication that it has reduced hospitalizations for chronic ailments. So I think the jury is still out on its long term impact on Medicare spending.

        The tax cuts were increasing federal revenues before the recession and will after the recession ends unless they are allowed to expire. Between 2003 and 2007 tax receipts grew at a 10% compounded rate. If the tax cuts are allowed to continue we should see a similar performance in tax receipts. The share of individual and corporate income taxes could be substantially higher if the tax cuts remain in place.

        I would love to see a consumption tax and the elimination of the income tax. But we would need a 20% VAT eventually to service our debt and social insurance programs.

      • Steven,

        I can personally assure you that even with a VAT of 20% you can have a lot of fun and must not sit half-naked in a dark cold room.

        All this tax stuff is debatable. My main points in regard to the US debt would be: You can not wage two wars without wading into debt. Never ever has this happened in history. And the tragic thing about these wars is, that even winning them won't bring the normal victory dividend.

        Now these two wars are either necessary or not. Can't really decide on that. But then the US is waging two more wars. Both senseless and insane. The war on drugs. Lost since decades for the cost of billions. And the war on terror. Fighting ghosts for no benefit.

        The US spending for defense is crazy. The US is making up for the shortcomings in the EU and elsewhere. Why? And why spend now more than in the Cold War? Crazy!

      • A bit of digression here from the budget. However, defense spending is necessary. We are the only superpower, we have a blue water navy, the only one in the world. We keep the sea lanes open. We are there to keep the oil choke points open. Our defense spending benefits the world. Our military is our state department. Our officer corps trains the world's military forces and forges close ties around the world. The cyberworld emerged so did cyber terror and crime more spending. The Chinese exploded a weapon in space, more spending. Non-state asymmetric actors, more spending. Unsecured nuclear weapons, more spending. Bio-terror more spending. A war that decimated our Army in terms of modernization put on hold, more spending.

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  17. what GDP growth rate did you use in your estimation? Guess I missed it.. or do you assume that the GDP is at the current level, i.e. negative gdp real growth?

  18. Too bad the data on your graphs didn't go back to the Reagan and two prior Bush administrations. I can understand why you didn't:

    From wikipedia: Here is a wikipedia finding:

    By tenure, the largest increases in gross debt relative to GDP, to date, occurred under George H.W. Bush (+11.2%), George W. Bush (+11.9%), and Ronald Reagan (+18.5%).

    Here is the data by tenure of office; what it shows is that Republican tax cuts increased the deficits:

    http://en.wikipedia.org/wiki/National_debt_by_U.S

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